• On the basis of purchasing power parity, the euro and the yen, the two most important currencies next to the U.S. dollar, are more than 20% over-valued against the greenback.
    • The financial markets have not budged much in recent months with respect to the Fed’s monetary policy. However, we are of the opinion that the foreign exchange markets have begun to fear a change in the Federal Reserve’s tone.
    • This, combined with the negative medium-term factor of a strong over-valuation, leads us to believe that the euro is set to decline in the face of cyclical factors that promise to be less favourable going forward.
    • The real test for the Canadian dollar will come more from an eventual upturn in the U.S. government bond yield curve than from a solo Canadian rate hike.
    • The behaviour of the employment component of the U.S. ISM manufacturing index suggests that the financial markets will soon begin to raise their Fed rate expectations. If so, the loonie would very likely shed a few cents.